An annual customer profitability analysis is a crucially important process for organizations to undertake. To put it simply, this process offers the opportunity to determine which customers are making your business money and which ones are not. It shows which customers have underserved opportunity to grow and which ones are a time drain for sales, marketing and finance teams.
I recently led a customer profitability initiative within a Fortune 1000 company with a multitude of product offerings. Based on my experience, there are three main areas to address:
- Establishing a set of quantitative KPIs across appropriate departments
- Identifying qualitative issues regarding servicing the customer
- Evaluating product mix profitability with the customers
Establishing Quantitative KPIs
Establishing key performance metrics is critical to customer profitability analysis. Large companies tend to undergo a lot of structural changes (e.g., system changes, team responsibility restructuring, customers acquiring other customers), so the key to analyzing these metrics is making sure the metrics are consistent year over year. This makes performance an apples-to-apples comparison, which is important as it will likely involve collecting data points across multiple departments.
Finance groups should be well versed on the overarching issues in other departments to get the full picture for the customer analysis. This is particularly important on the operational side. Most quantitative customer analysis tends to focus on gross margin aspects such as revenue and marketing/sales spend. While these are obviously extremely important, it is equally important to incorporate the full cost of the customer on the operations team.
Find out the number of employees and the number of hours it takes to service the customer effectively. What are their setup costs? What are shipping costs, if applicable? It is imperative to get quantitative data on all areas in which the customer interacts with the company to get a full picture of the customer profit margin.
While the focus on quantitative margin metrics is obviously warranted, it is also equally important to look at what qualitative aspects of the customer relationship affect profitability as well. Some customers are higher maintenance in ways that are more difficult to quantify, yet they still affect the bandwidth of your employees to drive revenue at other clients across the portfolio.
Some questions to ask to determine these metrics are:
- How often does the client email sales with questions/comments that are unnecessary?
- How difficult is the customer to please?
- How close is the overall relationship with the customer in general? Is it adversarial?
Difficult clients cannot only cost you time that you can be spending driving revenue at other customers, but also take a toll on employees. If working closely with difficult customers drives employees to leave your organization, that’s another indirect cost. Analyzing these factors can help your organization reduce exposure to the drawbacks associated with this type of customer and help optimize time with other customers.
In one case, I witnessed an organization dramatically cut the time spent with a very high maintenance, but large, customer. The hours and effort redirected by employees to other accounts resulted in a total revenue increase that covered the loss in revenue from the high maintenance account, plus drove an additional 15%.
This type of analysis can make a substantive difference in optimizing personnel to increase profit margin. While certain accounts that have a large profit share may also be high maintenance, the exercise can help increase the profit share of other accounts and help lower their power and influence over your organization.
Product Mix Analysis
For larger organizations that offer multiple products and brands to sell to a customer, targeting the correct mix of products to sell them is also key to customer profitability analysis.
To do this effectively, it’s a two-step process. First, you must obtain metrics on and rank the overall profitability of products/brands in the overall company portfolio. Second, you must evaluate each customer’s usage of these products and where they index on usage opposed to overall customer base.
This effort can help determine if a particular customer’s higher utilization of less profitable products/services causes the customer’s overall profitability to suffer. Then your organization can recalibrate the types of products or services on which marketing/sales focuses their efforts with that customer to increase profitability. This can also help your organization better optimize marketing or sales spend on a particular customer. If a customer has to use a particular product or service that has low margins more than other customers do, then as a counter, you can set a tighter budget on marketing spend on that customer to compensate and drive profit margins upward.
Analyzing customer profitability is a critical process that organizations can use to optimize their personnel and budget to achieve the best profit margins possible. With a deep-dive analysis into consistent and established quantitative KPIs, an evaluation of qualitative customer KPIs and analysis of product mix offered, organizations can effectively set the course for faster growth and higher profit.
Bringing in Customer Profitability Experts
If you’re looking for help with profitability, or if you’re thinking about bringing in financial consultants, then we invite you to contact us at 8020 Consulting! We offer outside expertise with industry best practices and would be happy to help you define your needs and offer advice on next steps.
We also offer more insight into financial planning & analysis in our free forecasting process ebook. To download it, click the button below:
About the Author
Justin comes from a diverse background of Sales Operations Finance, FP&A, Strategic Finance, and business analytics within the Media, Entertainment and Consumer Products industries. Prior to joining 8020 Consulting, Justin served as a Sales Finance Analyst for Mattel, the world’s largest toy manufacturer. He also worked in FP&A in with various other Fortune 500 Companies such as Warner Bros and Time Warner Cable. His specialties include financial modeling, budgeting and forecasting, data analytics and strategic finance. He attended the University of Michigan, Ann Arbor, where he received his Bachelor’s Degree in Political Science. He later received his MBA from the University of Southern California with a focus on Corporate Finance and Valuation.